DE LA SALLE UNIVERSITY MANILA
RVR – COB DEPARTMENT OF ACCOUNTANCY
ACCCOB2 TERM 1 AY 22 - 23
ACCCOB2 Lecture 1
Prof. Francis H. Villamin
INTRODUCTION TO FINANCIAL ACCOUNTING
DEFINITION / NATURE OF ACCOUNTING
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Accounting is a service activity. Its function is to provide quantitative information, primarily
financial in nature, about economic entities, that is intended to be useful in making economic
decision.
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Accounting is both a science and an art
▪ Accounting is a social science with a body of knowledge which has been systematically
gathered, classified and organized.
▪ Accounting is a practical art which requires the use of creative skill and judgment.
FUNCTIONS OF ACCOUNTING
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Identification – it is the accounting process of recognition or non-recognition of business
activities as accountable events or whether they have accounting relevance.
▪ An accountable event is an event that is quantifiable and has an effect on assets, liabilities
and equity. This is also known as an economic activity.
▪ An event is considered an accountable event if it meets the following criteria:
• It affects an element of financial statements
• It is a result of past activity
• It has a cost that can be measured reliably
▪
Only economic activities are emphasized and recognized in accounting. Sociological
and psychological matters are not recognized.
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Measurement – it is the accounting process of assigning peso amount or numbers to the
economic transactions and events. The unit of measure is money, which is expressed in
prices.
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Communication – it is the accounting process of preparing and distributing accounting
reports to potential users of accounting information and interpreting the significance of the
processed information.
▪
The communication process of accounting involves the following three aspects:
• Recording – it is the process of systematically putting into writing business transactions
and events after they have been identified and measured in the books of account in a
systematic and chronological manner according to accounting rules and regulations.
• Classifying – it is the grouping of similar and interrelated items into their respective
classes.
• Summarizing – it is the putting together or expressing in condensed or brief form the
recorded and classified transactions and events. This includes the preparation of
financial statements which include the statement of financial position, the income
statement, the statement of cash flows, and the statement of changes in owners’ equity
and the notes and schedules.
USES OF ACCOUNTING INFORMATION
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Making decisions affecting the allocation of limited resources.
Directing and controlling an organization’s human and material resources.
Maintaining and reporting on the stewardship of the resources.
Facilitating social functions and controls.
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BRANCHES OF ACCOUNTING / AREAS OF SPECIALIZATION
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Financial accounting
▪ It focuses on the development and communication of financial information to external users,
particularly the creditors and investors.
• Creditors need information about the profitability and stability of the entity.
• Investors need information concerning the safety and profitability of their investment.
▪
It is basically concerned with providing general-purpose financial statements
• Preparation of the general-purpose financial statements involves the use of generally
accepted accounting principles or standards.
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Management accounting
▪ It focuses on the development and communication of financial information to internal users
• Internal users need information to assist them in planning and controlling the operations
of the entity and in managing the entity resources.
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Auditing
▪ It focuses on the examination of financial statements by an independent certified public
accountant for the purpose of expressing an opinion on the fairness of presentation of
financial statements.
• External users such as creditors and prospective investors place much reliance on
audited financial statements in making economic decisions.
•
Government accounting
▪ It encompasses the process of analyzing, classifying, summarizing, and communicating all
transactions involving the receipt and disposition of government funds and property and
interpreting the results thereof.
▪ It focuses attention on the custody and administration of public funds and the purpose or
purposes to which such funds are committed.
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Taxation services
▪ It focuses on the preparation of tax returns and rendering of tax advice, such as
determination of tax consequences of certain proposed business endeavors.
Financial Statements
These are the means by which information accumulated and processed in financial accounting is
periodically communicated to the users. They are the end-product of the accounting process.
They are also a structured financial representation of the financial position and financial performance of
an entity.
General-Purpose Financial Statements
These are statements that have been prepared for the common needs of wide range of users.
A complete set of financial statements comprises the following:
1. Statement of Financial Position (also known as Balance Sheet)
2. Statement of Comprehensive Income (Income Statement and Other Comprehensive
Income)
3. Statement of Changes in Equity
4. Statement of Cash Flows
5. Notes, comprising a summary of significant accounting policies and explanatory notes.
ACCOUNTING STANDARDS and STANDARD SETTING
ACCOUNTING STANDARDS
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Definition of accounting standards
▪ They are the official statements issued by standard setting bodies that serve as rules in the
preparation of financial statements.
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Nature of accounting standards
▪ The issued statements of accounting standards (PFRS) constitute the generally accepted
accounting principles (GAAP) at a particular time
▪ They guide the accountants in the preparation of financial statements of the various reporting
entities.
▪ They are established and improved, if necessary, by the Financial Reporting Standards
Council (FRSC), the new standard-setting body in the Philippines. The predecessor standardsetting body was Accounting Standards Council (ASC).
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Scope and authority of Philippine Financial Reporting Standards (PFRSs)
▪ They set out recognition, measurement, presentation and disclosure requirements dealing
with transaction and events that are important in general-purpose financial statements and
those that may arise mainly in specific industries.
▪ They are based on the Framework.
▪ They are designed to apply to the general-purpose financial statement and other financial
reporting of all profit-oriented entities.
• Profit-oriented entities include those engaged in commercial, industrial, financial and
similar activities
• General-purpose financial statements are directed towards the common information
needs of a wide range of users.
▪ In some cases, PFRSs permit different treatments for given transactions and events.
• One treatment is identified as the “benchmark treatment” and the other as the “allowed
alternative treatment”. The financial statements can still be described as being prepared
in accordance with PFRSs whether they use the benchmark treatment or the allowed
alternative treatment.
INSTITUTIONS, PROFESSIONAL BODIES AND STANDARD-SETTING DUE PROCESS
(1)
The FRSC
The Financial Reporting Standards Council (FRSC) was established by the Board of Accountancy (BOA
or the Board) in 2006 under the implementing Rules and Regulations of the Philippine Accountancy Act
of 2004 to assist the Board in carrying out its power and function to promulgate accounting standards in
the Philippines.
2.
Scope and Authority of PFRSs
(1)
The FRSC issues its Standards in a series of pronouncements called Philippine Financial
Reporting Standards (PFRSs). These consist of:
(a) Philippine Financial Reporting Standards (PFRSs). These correspond to the International
Financial Reporting Standards (IFRSs);
(b) Philippine Accounting Standards (PASs). These correspond to the International Accounting
Standards (IASs); and
(c) Philippine Interpretations. These correspond to Interpretations of the IFIRC and the Standard
Interpretations Committee (SIC) of the IASC. These also include Interpretations developed by
the PIC.
(2)
The FRSC achieves its objectives primarily by developing and issuing Philippine Financial
Reporting Standards (PFRSs) and promoting the use of these standards in general purpose
financial statements and other financial reporting.
(3)
PFRSs set out the recognition, measurement, presentation and disclosure requirements dealing
with transactions and events that are important in general purpose financial statements. They may
also set out such requirements for the transactions and events that arise mainly in specific
industries. The Framework also provides a basis for the use of judgment in resolving accounting
issues.
(4)
PFRSs are designed to apply the general-purpose financial statements and other financial reporting
of all profit-oriented entities. Profit-oriented entities include those engaged in commercial,
industrial, financial and similar activities, whether organized in corporate or any other forms.
They include organizations such as mutual insurance companies and other mutual
cooperative entities that provide dividends or other economic benefits directly and
proportionately to their owners, members or participants. Although PFRSs are not designed to
apply to not-for profit activities in private sector, public sector or government, entities with such
activities may find them appropriate.
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PFRSs apply to all general-purpose financial statements. These financial statements are directed
towards the common information needs of a wide range of users, for example, shareholders,
creditors, employees and the public at large.
The objective of the financial statements is to provide information about the financial position,
performance and cash flows of an entity that is useful to those users in making economic decisions.
(6)
A complete set of financial statements include a statement of financial position ( or balance sheet),
a statement of comprehensive income, a statement showing either all changes in equity or changes
in equity other than those arising from capital transactions with owners and distribution to owners, a
cash flow statement, and accounting policies and explanatory notes.
(7)
Interpretations of PFRSs are intended to give authoritative guidance on issues that are likely to
receive divergent or unacceptable treatment in the absence of such guidance.
BASIC ACCOUNTING CONCEPTS
1. Entity Concept – Under entity concept, the business is regarded as having a separate and
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distinct personality from that of owner/s – generating its own revenue, incurring its own
expenses, and owing its own liabilities.
Going Concern Concept - This concept assumes that the business is to continue its operations
indefinitely. This means that the business will stay in operation for a period of time sufficient to
carry out contemplated operations, contracts and commitments.
Time Period or Periodicity Concept – This concept divides the life of the business into regular
intervals (usually one year) at the end of which financial statements are prepared. This means
that the economic activities undertaken during the life of an accounting entity are assumed to be
divisible into various artificial time periods
Monetary Concept – Under this concept, money is used as the unit of measure in preparing the
various financial reports of the company.
Cost Concept – This concept assumes that assets are acquired in business transactions
conducted at arm’s length transactions.
Accrual Concept – This concept requires that income be recorded when earned regardless
whether cash is received and an expense be recognized when incurred regardless whether
payment is made.
Revenue Realization Concept – This concept provides that income is recognized when earned
regardless whether cash is received.
Matching Concept – This concept states that all expenses incurred to generate revenues must
be recorded in the same period that the income are recorded to properly determine net income
or net loss of the period.
Verifiability Concept – This concept requires that all transactions must be evidenced by the
business documents free from personal biases and independent CPAs can verify reports.
Materiality Concept – This concept refers to relative importance of an item. An item is
considered material if knowledge of it would influence the decision of prudent users of financial
statements.
Disclosure Concept – Under this concept, all relevant and material events affecting the
financial condition/position of a business and the results of its operations must be communicated
to users of financial statements.
FRAMEWORK FOR THE PREPARATION AND
PRESENTATION OF FINANCIAL STATEMENTS
I. DEFINITION OF CONCEPTUAL FRAMEWORK
A conceptual framework is a coherent system of interrelated basic concepts and propositions that
prescribe objectives, limits, and other fundamentals of financial accounting and serves as a basis for
developing and evaluating accounting principles and resolving accounting and reporting controversies.
Basic Concepts – are ideas derived from observations of the environment in which financial accounting
takes place. They constitute the foundations on which less fundamental but equally important concepts
rest.
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Topics under the 2018 Conceptual Framework
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Purpose and Status
Scope
Objective of General-Purpose Financial Reporting
The Reporting Entity
Qualitative Characteristics of Useful Financial Information
The Rest of the Old Framework
Purpose and Status of the Conceptual Framework
This Conceptual Framework sets out the concepts that underlie the preparation and presentation of
financial statements for external users. The purpose of the Conceptual Framework is:
(a) to assist the FRSC in its development of future FRSs and in its review of existing FRSs;
(b) to assist the FRSC in promoting harmonization of regulations, accounting standards and
procedures relating to the presentation of financial statements by providing a basis for reducing
the number of alternative accounting treatments permitted by FRSs;
(c) to assist preparers of financial statements in applying IFRSs and in dealing with topics that have
yet to form the subject of an IFRS;
(d) to assist auditors in forming an opinion on whether financial statements comply with IFRSs;
(e) to assist users of financial statements in interpreting the information contained in financial
statements prepared in compliance with IFRSs; and
(f) to provide those who are interested in the work of the IASB with information about its approach to
the formulation of IFRSs.
Scope
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This Conceptual Framework is not an IFRS and hence does not define standards for any particular
measurement or disclosure issue. Nothing in this Conceptual Framework overrides any specific IFRS.
The Board recognizes that in a limited number of cases there may be a conflict between the
Conceptual Framework and an IFRS. In those cases where there is a conflict, the requirements of the
IFRS prevail over those of the Conceptual Framework. As, however, the Board will be guided by the
Conceptual Framework in the development of future IFRSs and in its review of existing IFRSs, the
number of cases of conflict between the Conceptual Framework and IFRSs will diminish through time.
The Conceptual Framework will be revised from time to time on the basis of the Board’s experience
of working with it.
Objective of General-Purpose Financial Reporting
Introduction
The objective of general-purpose financial reporting forms the foundation of the Conceptual Framework.
Other aspects of the Conceptual Framework—a reporting entity concept, the qualitative characteristics of,
and the constraint on, useful financial information, elements of financial statements, recognition,
measurement, presentation and disclosure—flow logically from the objective.
Objective, usefulness and limitations of general-purpose financial reporting
The objective of general-purpose financial reporting is to provide financial information about the reporting
entity that is useful to existing and potential investors, lenders and other creditors in making decisions
about providing resources to the entity. Those decisions involve buying, selling or holding equity and debt
instruments, and providing or settling loans and other forms of credit.
Decisions by existing and potential investors about buying, selling or holding equity and debt instruments
depend on the returns that they expect from an investment in those instruments, for example dividends,
principal and interest payments or market price increases. Similarly, decisions by existing and potential
lenders and other creditors about providing or settling loans and other forms of credit depend on the
principal and interest payments or other returns that they expect. Investors’, lenders’ and other creditors’
expectations about returns depend on their assessment of the amount, timing and uncertainty of (the
prospects for) future net cash inflows to the entity. Consequently, existing and potential investors, lenders
and other creditors need information to help them assess the prospects for future net cash inflows to an
entity.
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To assess an entity’s prospects for future net cash inflows, existing and potential investors, lenders and
other creditors need information about the resources of the entity, claims against the entity, and how
efficiently and effectively the entity’s management and governing board† have discharged their
responsibilities to use the entity’s resources. Examples of such responsibilities include protecting the
entity’s resources from unfavorable effects of economic factors such as price and technological changes
and ensuring that the entity complies with applicable laws, regulations and contractual provisions.
Information about management’s discharge of its responsibilities is also useful for decisions by existing
investors, lenders and other creditors who have the right to vote on or otherwise influence management’s
actions.
Many existing and potential investors, lenders and other creditors cannot require reporting entities to
provide information directly to them and must rely on general purpose financial reports for much of the
financial information they need. Consequently, they are the primary users to whom general purpose
financial reports are directed.
However, general purpose financial reports do not and cannot provide all of the information that existing
and potential investors, lenders and other creditors need. Those users need to consider pertinent
information from other sources, for example, general economic conditions and expectations, political
events and political climate, and industry and company outlooks.
General purpose financial reports are not designed to show the value of a reporting entity; but they
provide information to help existing and potential investors, lenders and other creditors to estimate the
value of the reporting entity.
Individual primary users have different, and possibly conflicting, information needs and desires. The
Board, in developing financial reporting standards, will seek to provide the information set that will meet
the needs of the maximum number of primary users. However, focusing on common information needs
does not prevent the reporting entity from including additional information that is most useful to a
particular subset of primary users.
The management of a reporting entity is also interested in financial information about the entity. However,
management need not rely on general purpose financial reports because it is able to obtain the financial
information it needs internally.
Other parties, such as regulators and members of the public other than investors, lenders and other
creditors, may also find general purpose financial reports useful. However, those reports are not primarily
directed to these other groups.
To a large extent, financial reports are based on estimates, judgments and models rather than exact
depictions. The Conceptual Framework establishes the concepts that underlie those estimates,
judgments and models. The concepts are the goal towards which the Board and preparers of financial
reports strive.
As with most goals, the Conceptual Framework’s vision of ideal financial reporting is unlikely to be
achieved in full, at least not in the short term, because it takes time to understand, accept and implement
new ways of analyzing transactions and other events. Nevertheless, establishing a goal towards which to
strive is essential if financial reporting is to evolve so as to improve its usefulness
Information about a reporting entity’s economic resources, claims, and changes in resources and
claims
General purpose financial reports provide information about the financial position of a reporting entity,
which is information about the entity’s economic resources and the claims against the reporting entity.
Financial reports also provide information about the effects of transactions and other events that change
a reporting entity’s economic resources and claims. Both types of information provide useful input for
decisions about providing resources to an entity.
Economic resources and claims
Information about the nature and amounts of a reporting entity’s economic resources and claims can help
users to identify the reporting entity’s financial strengths and weaknesses. That information can help
users to assess the reporting entity’s liquidity and solvency, its needs for additional financing and how
successful it is likely to be in obtaining that financing. Information about priorities and payment
requirements of existing claims helps users to predict how future cash flows will be distributed among
those with a claim against the reporting entity.
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Different types of economic resources affect a user’s assessment of the reporting entity’s prospects for
future cash flows differently. Some future cash flows result directly from existing economic resources,
such as accounts receivable. Other cash flows result from using several resources in combination to
produce and market goods or services to customers. Although those cash flows cannot be identified with
individual economic resources (or claims), users of financial reports need to know the nature and amount
of the resources available for use in a reporting entity’s operations.
Changes in economic resources and claims
Changes in a reporting entity’s economic resources and claims result from that entity’s financial
performance and from other events or transactions such as issuing debt or equity instruments. To
properly assess the prospects for future cash flows from the reporting entity, users need to be able to
distinguish between both of these changes.
Information about a reporting entity’s financial performance helps users to understand the return that the
entity has produced on its economic resources. Information about the return the entity has produced
provides an indication of how well management has discharged its responsibilities to make efficient and
effective use of the reporting entity’s resources. Information about the variability and components of that
return is also important, especially in assessing the uncertainty of future cash flows. Information about a
reporting entity’s past financial performance and how its management discharged its responsibilities is
usually helpful in predicting the entity’s future returns on its economic resources.
Financial performance reflected by accrual accounting
Accrual accounting depicts the effects of transactions and other events and circumstances on a reporting
entity’s economic resources and claims in the periods in which those effects occur, even if the resulting
cash receipts and payments occur in a different period. This is important because information about a
reporting entity’s economic resources and claims and changes in its economic resources and claims
during a period provides a better basis for assessing the entity’s past and future performance than
information solely about cash receipts and payments during that period.
Information about a reporting entity’s financial performance during a period, reflected by changes in its
economic resources and claims other than by obtaining additional resources directly from investors and
creditors, is useful in assessing the entity’s past and future ability to generate net cash inflows. That
information indicates the extent to which the reporting entity has increased its available economic
resources, and thus its capacity for generating net cash inflows through its operations rather than by
obtaining additional resources directly from investors and creditors.
Information about a reporting entity’s financial performance during a period may also indicate the extent
to which events such as changes in market prices or interest rates have increased or decreased the
entity’s economic resources and claims, thereby affecting the entity’s ability to generate net cash inflows.
Financial performance reflected by past cash flows
Information about a reporting entity’s cash flows during a period also helps users to assess the entity’s
ability to generate future net cash inflows. It indicates how the reporting entity obtains and spends cash,
including information about its borrowing and repayment of debt, cash dividends or other cash
distributions to investors, and other factors that may affect the entity’s liquidity or solvency.
Information about cash flows helps users understand a reporting entity’s operations, evaluate its financing
and investing activities, assess its liquidity or solvency and interpret other information about financial
performance.
Changes in economic resources and claims not resulting from financial performance
A reporting entity’s economic resources and claims may also change for reasons other than financial
performance, such as issuing additional ownership shares. Information about this type of change is
necessary to give users a complete understanding of why the reporting entity’s economic resources and
claims changed and the implications of those changes for its future financial performance.
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Qualitative characteristics of useful financial information
Introduction
The qualitative characteristics of useful financial information discussed in the Framework identify the
types of information that are likely to be most useful to the existing and potential investors, lenders and
other creditors for making decisions about the reporting entity on the basis of information in its financial
report (financial information).
Financial reports provide information about the reporting entity’s economic resources, claims against the
reporting entity and the effects of transactions and other events and conditions that change those
resources and claims. (This information is referred to in the Conceptual Framework as information about
the economic phenomena.) Some financial reports also include explanatory material about
management’s expectations and strategies for the reporting entity, and other types of forward-looking
information.
The qualitative characteristics of useful financial information apply to financial information provided in
financial statements, as well as to financial information provided in other ways. Cost, which is a pervasive
constraint on the reporting entity’s ability to provide useful financial information, applies similarly.
However, the considerations in applying the qualitative characteristics and the cost constraint may be
different for different types of information. For example, applying them to forward-looking information may
be different from applying them to information about existing economic resources and claims and to
changes in those resources and claims.
Qualitative characteristics of useful financial information
If financial information is to be useful, it must be relevant and faithfully represent what it purports to
represent. The usefulness of financial information is enhanced if it is comparable, verifiable, timely and
understandable.
Fundamental qualitative characteristics
The fundamental qualitative characteristics are relevance and faithful representation.
Relevance
Relevant financial information is capable of making a difference in the decisions made by users.
Information may be capable of making a difference in a decision even if some users choose not to take
advantage of it or are already aware of it from other sources.
Financial information is capable of making a difference in decisions if it has predictive value, confirmatory
value or both.
Financial information has predictive value if it can be used as an input to processes employed by users to
predict future outcomes. Financial information need not be a prediction or forecast to have predictive
value. Financial information with predictive value is employed by users in making their own predictions.
Financial information has confirmatory value if it provides feedback about (confirms or changes) previous
evaluations.
The predictive value and confirmatory value of financial information are interrelated. Information that has
predictive value often also has confirmatory value. For example, revenue information for the current year,
which can be used as the basis for predicting revenues in future years, can also be compared with
revenue predictions for the current year that were made in past years. The results of those comparisons
can help a user to correct and improve the processes that were used to make those previous predictions.
Materiality
Information is material if omitting it or misstating it could influence decisions that users make on the basis
of financial information about a specific reporting entity. In other words, materiality is an entity-specific
aspect of relevance based on the nature or magnitude, or both, of the items to which the information
relates in the context of an individual entity’s financial report. Consequently, the Board cannot specify a
uniform quantitative threshold for materiality or predetermine what could be material in a particular
situation.
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Faithful representation
Financial reports represent economic phenomena in words and numbers. To be useful, financial
information must not only represent relevant phenomena, but it must also faithfully represent the
phenomena that it purports to represent. To be a perfectly faithful representation, a depiction would have
three characteristics. It would be complete, neutral and free from error. Of course, perfection is seldom, if
ever, achievable. The Board’s objective is to maximize those qualities to the extent possible.
A complete depiction includes all information necessary for a user to understand the phenomenon being
depicted, including all necessary descriptions and explanations. For example, a complete depiction of a
group of assets would include, at a minimum, a description of the nature of the assets in the group, a
numerical depiction of all of the assets in the group, and a description of what the numerical depiction
represents (for example, original cost, adjusted cost or fair value). For some items, a complete depiction
may also entail explanations of significant facts about the quality and nature of the items, factors and
circumstances that might affect their quality and nature, and the process used to determine the numerical
depiction.
A neutral depiction is without bias in the selection or presentation of financial information. A neutral
depiction is not slanted, weighted, emphasized, de-emphasized or otherwise manipulated to increase the
probability that financial information will be received favorably or unfavorably by users. Neutral
information does not mean information with no purpose or no influence on behavior. On the contrary,
relevant financial information is, by definition,
capable of making a difference in users’ decisions.
Faithful representation does not mean accurate in all respects. Free from error means there are no errors
or omissions in the description of the phenomenon, and the process used to produce the reported
information has been selected and applied with no errors in the process. In this context, free from error
does not mean perfectly accurate in all respects. For example, an estimate of an unobservable price or
value cannot be determined to be accurate or inaccurate. However, a representation of that estimate can
be faithful if the amount is described clearly and accurately as being an estimate, the nature and
limitations of the estimating process are explained, and no errors have been made in selecting and
applying an appropriate process for developing the estimate.
A faithful representation, by itself, does not necessarily result in useful information. For example, a
reporting entity may receive property, plant and equipment through a government grant. Obviously,
reporting that an entity acquired an asset at no cost would faithfully represent its cost, but that information
would probably not be very useful. A slightly more subtle example is an estimate of the amount by which
an asset’s carrying amount should be adjusted to reflect an impairment in the asset’s value. That estimate
can be a faithful representation if the reporting entity has properly applied an appropriate process,
properly described the estimate and explained any uncertainties that significantly affect the estimate.
However, if the level of uncertainty in such an estimate is sufficiently large, that estimate will not be
particularly useful. In other words, the relevance of the asset being faithfully represented is questionable.
If there is no alternative representation that is more faithful, that estimate may provide the best available
information.
Applying the fundamental qualitative characteristics
Information must be both relevant and faithfully represented if it is to be useful. Neither a faithful
representation of an irrelevant phenomenon nor an unfaithful representation of a relevant phenomenon
helps users make good decisions.
The most efficient and effective process for applying the fundamental qualitative characteristics would
usually be as follows (subject to the effects of enhancing characteristics and the cost constraint, which
are not considered in this example).
First, identify an economic phenomenon that has the potential to be useful to users of the reporting
entity’s financial information. Second, identify the type of information about that phenomenon that would
be most relevant if it is available and can be faithfully represented. Third, determine whether that
information is available and can be faithfully represented. If so, the process of satisfying the fundamental
qualitative characteristics ends at that point. If not, the process is repeated with the next most relevant
type of information.
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Enhancing qualitative characteristics
Comparability, verifiability, timeliness and understandability are qualitative characteristics that enhance
the usefulness of information that is relevant and faithfully represented. The enhancing qualitative
characteristics may also help determine which of two ways should be used to depict a phenomenon if
both are considered equally relevant and faithfully represented.
Comparability
Users’ decisions involve choosing between alternatives, for example, selling or holding an investment, or
investing in one reporting entity or another. Consequently, information about a reporting entity is more
useful if it can be compared with similar information about other entities and with similar information about
the same entity for another period or another date.
Comparability is the qualitative characteristic that enables users to identify and understand similarities in,
and differences among, items. Unlike the other qualitative characteristics, comparability does not relate to
a single item. A comparison requires at least two items.
Consistency, although related to comparability, is not the same. Consistency refers to the use of the
same methods for the same items, either from period to period within a reporting entity or in a single
period across entities.
Comparability is the goal; consistency helps to achieve that goal.
Comparability is not uniformity. For information to be comparable, like things must look alike and different
things must look different. Comparability of financial information is not enhanced by making unlike things
look alike any more than it is enhanced by making like things look different.
Some degree of comparability is likely to be attained by satisfying the fundamental qualitative
characteristics. A faithful representation of a relevant economic phenomenon should naturally possess
some degree of comparability with a faithful representation of a similar relevant economic phenomenon
by another reporting entity.
Although a single economic phenomenon can be faithfully represented in multiple ways, permitting
alternative accounting methods for the same economic phenomenon diminishes comparability.
Verifiability
Verifiability helps assure users that information faithfully represents the economic phenomena it purports
to represent. Verifiability means that different knowledgeable and independent observers could reach
consensus, although not necessarily complete agreement, that a particular depiction is a faithful
representation. Quantified information need not be a single point estimate to be verifiable. A range of
possible amounts and the related probabilities can also be verified.
Verification can be direct or indirect. Direct verification means verifying an amount or other representation
through direct observation, for example, by counting cash. Indirect verification means checking the inputs
to a model, formula or other technique and recalculating the outputs using the same methodology.
An example is verifying the carrying amount of inventory by checking the inputs (quantities and costs) and
recalculating the ending inventory using the same cost flow assumption (for example, using the first-in,
first-out method).
It may not be possible to verify some explanations and forward-looking financial information until a future
period, if at all. To help users decide whether they want to use that information, it would normally be
necessary to disclose the underlying assumptions, the methods of compiling the information and other
factors and circumstances that support the information.
Timeliness
Timeliness means having information available to decision-makers in time to be capable of influencing
their decisions. Generally, the older the information is the less useful it is. However, some information
may continue to be timely long after the end of a reporting period because, for example, some users may
need to identify and assess trends.
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Understandability
Classifying, characterizing and presenting information clearly and concisely make it understandable.
Some phenomena are inherently complex and cannot be made easy to understand. Excluding
information about those phenomena from financial reports might make the information in those financial
reports easier to understand. However, those reports would be incomplete and therefore potentially
misleading.
Financial reports are prepared for users who have a reasonable knowledge of business and economic
activities and who review and analyze the information diligently. At times, even well-informed and diligent
users may need to seek the aid of an adviser to understand information about complex economic
phenomena.
Applying the enhancing qualitative characteristics
Enhancing qualitative characteristics should be maximized to the extent possible. However, the
enhancing qualitative characteristics, either individually or as a group, cannot make information useful if
that information is irrelevant or not faithfully represented.
Applying the enhancing qualitative characteristics is an iterative process that does not follow a prescribed
order. Sometimes, one enhancing qualitative characteristic may have to be diminished to maximize
another qualitative characteristic. For example, a temporary reduction in comparability as a result of
prospectively applying a new financial reporting standard may be worthwhile to improve relevance or
faithful representation in the longer term. Appropriate disclosures may partially compensate for noncomparability.
The cost constraint on useful financial reporting
Cost is a pervasive constraint on the information that can be provided by financial reporting. Reporting
financial information imposes costs, and it is important that those costs are justified by the benefits of
reporting that information. There are several types of costs and benefits to consider.
Providers of financial information expend most of the effort involved in collecting, processing, verifying
and disseminating financial information, but users ultimately bear those costs in the form of reduced
returns. Users of financial information also incur costs of analyzing and interpreting the information
provided. If needed information is not provided, users incur additional costs to obtain that information
elsewhere or to estimate it.
Reporting financial information that is relevant and faithfully represents what it purports to represent helps
users to make decisions with more confidence. This results in more efficient functioning of capital markets
and a lower cost of capital for the economy as a whole. An individual investor, lender or other creditor
also receives benefits by making more informed decisions. However, it is not possible for general purpose
financial reports to provide all the information that every user finds relevant.
In applying the cost constraint, the Board assesses whether the benefits of reporting particular
information are likely to justify the costs incurred to provide and use that information. When applying the
cost constraint in developing a proposed financial reporting standard, the Board seeks information from
providers of financial information, users, auditors, academics and others about the expected nature and
quantity of the benefits and costs of that standard. In most situations, assessments are based on a
combination of quantitative and qualitative information.
Because of the inherent subjectivity, different individuals’ assessments of the costs and benefits of
reporting particular items of financial information will vary. Therefore, the Board seeks to consider costs
and benefits in relation to financial reporting generally, and not just in relation to individual reporting
entities. That does not mean that assessments of costs and benefits always justify the same reporting
requirements for all entities. Differences may be appropriate because
of different sizes of entities, different ways of raising capital (publicly or privately), different users’ needs or
other factors.
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Underlying assumption
Going concern
The financial statements are normally prepared on the assumption that an entity is a going concern and
will continue in operation for the foreseeable future. Hence, it is assumed that the entity has neither the
intention nor the need to liquidate or curtail materially the scale of its operations; if such an intention or
need exists, the financial statements may have to be prepared on a different basis and, if so, the basis
used is disclosed.
The elements of financial statements
Financial statements portray the financial effects of transactions and other events by grouping them into
broad classes according to their economic characteristics. These broad classes are termed the elements
of financial statements. The elements directly related to the measurement of financial position in the
balance sheet are assets, liabilities and equity. The elements directly related to the measurement of
performance in the income statement are income and expenses. The statement of changes in financial
position usually reflects income statement elements and changes in balance sheet elements; accordingly,
this Conceptual Framework identifies no elements that are unique to this statement. The presentation of
these elements in the balance sheet and the income statement involves a process of sub-classification.
For example, assets and liabilities may be classified by their nature or function in the business of the
entity in order to display information in the manner most useful to users for purposes of making economic
decisions.
Financial position
The elements directly related to the measurement of financial position are assets, liabilities and equity.
These are defined as follows:
(a) An asset is a resource controlled by the entity as a result of past events and from which future
economic benefits are expected to flow to the entity.
(b) A liability is a present obligation of the entity arising from past events, the settlement of which is
expected to result in an outflow from the entity of resources embodying economic benefits.
(c) Equity is the residual interest in the assets of the entity after deducting all its liabilities.
The definitions of an asset and a liability identify their essential features but do not attempt to specify the
criteria that need to be met before they are recognized in the balance sheet. Thus, the definitions
embrace items that are not recognized as assets or liabilities in the balance sheet because they do not
satisfy the criteria for recognition discussed in later paragraphs. In particular, the expectation that future
economic benefits will flow to or from an entity must be sufficiently certain to meet the probability criterion
before an asset or liability is recognized.
In assessing whether an item meets the definition of an asset, liability or equity, attention needs to be
given to its underlying substance and economic reality and not merely its legal form. Thus, for example, in
the case of finance leases, the substance and economic reality are that the lessee acquires the economic
benefits of the use of the leased asset for the major part of its useful life in return for entering into an
obligation to pay for that right an amount approximating to the fair value of the asset and the related
finance charge. Hence, the finance lease gives rise to items that satisfy the definition of an asset and a
liability and are recognized as such in the lessee’s balance sheet.
Balance sheets drawn up in accordance with current IFRSs may include items that do not satisfy the
definitions of an asset or liability and are not shown as part of equity.
Assets
The future economic benefit embodied in an asset is the potential to contribute, directly or indirectly, to
the flow of cash and cash equivalents to the entity. The potential may be a productive one that is part of
the operating activities of the entity. It may also take the form of convertibility into cash or cash
equivalents or a capability to reduce cash outflows, such as when an alternative manufacturing process
lowers the costs of production.
An entity usually employs its assets to produce goods or services capable of satisfying the wants or
needs of customers; because these goods or services can satisfy these wants or needs, customers are
prepared to pay for them and hence contribute to the cash flow of the entity. Cash itself renders a service
to the entity because of its command over other resources.
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The future economic benefits embodied in an asset may flow to the entity in a number of ways. For
example, an asset may be:
(a) used singly or in combination with other assets in the production of goods or services to be sold
by the entity;
(b) exchanged for other assets;
(c) used to settle a liability; or
(d) distributed to the owners of the entity.
Many assets, for example, property, plant and equipment, have a physical form. However, physical form
is not essential to the existence of an asset; hence patents and copyrights, for example, are assets if
future economic benefits are expected to flow from them to the entity and if they are controlled by the
entity.
Many assets, for example, receivables and property, are associated with legal rights, including the right of
ownership. In determining the existence of an asset, the right of ownership is not essential; thus, for
example, property held on a lease is an asset if the entity controls the benefits which are expected to flow
from the property. Although the capacity of an entity to control benefits is usually the result of legal rights,
an item may nonetheless satisfy the definition of an asset even when there is no legal control. For
example, know-how obtained from a development activity may meet the definition of an asset when, by
keeping that know-how secret, an entity controls the benefits that are expected to flow from it.
The assets of an entity result from past transactions or other past events. Entities normally obtain assets
by purchasing or producing them, but other transactions or events may generate assets; examples
include property received by an entity from government as part of a program to encourage economic
growth in an area and the discovery of mineral deposits. Transactions or events expected to occur in the
future do not in themselves give rise to assets; hence, for example, an intention to purchase inventory
does not, of itself, meet the definition of an asset.
There is a close association between incurring expenditure and generating assets but the two do not
necessarily coincide. Hence, when an entity incurs expenditure, this may provide evidence that future
economic benefits were sought but is not conclusive proof that an item satisfying the definition of an asset
has been obtained. Similarly, the absence of a related expenditure does not preclude an item from
satisfying the definition of an asset and thus becoming a candidate for recognition in the balance sheet;
for example, items that have been donated to the entity may satisfy the definition of an asset.
Liabilities
An essential characteristic of a liability is that the entity has a present obligation. An obligation is a duty or
responsibility to act or perform in a certain way. Obligations may be legally enforceable as a consequence
of a binding contract or statutory requirement. This is normally the case, for example, with amounts
payable for goods and services received. Obligations also arise, however, from normal business practice,
custom and a desire to maintain good business relations or act in an equitable manner. If, for example, an
entity decides as a matter of policy to rectify faults in its products even when these become apparent after
the warranty period has expired, the amounts that are expected to be expended in respect of goods
already sold are liabilities.
A distinction needs to be drawn between a present obligation and a future commitment. A decision by the
management of an entity to acquire assets in the future does not, of itself, give rise to a present
obligation. An obligation normally arises only when the asset is delivered or the entity enters into an
irrevocable agreement to acquire the asset. In the latter case, the irrevocable nature of the agreement
means that the economic consequences of failing to honor the obligation, for example, because of the
existence of a substantial penalty, leave the entity with little, if any, discretion to avoid the outflow of
resources to another party.
The settlement of a present obligation usually involves the entity giving up resources embodying
economic benefits in order to satisfy the claim of the other party. Settlement of a present obligation may
occur in a number of ways, for example, by:
(a) payment of cash;
(b) transfer of other assets;
(c) provision of services;
(d) replacement of that obligation with another obligation; or
(e) conversion of the obligation to equity.
(f) An obligation may also be extinguished by other means, such as a creditor waiving or forfeiting its
rights.
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Liabilities result from past transactions or other past events. Thus, for example, the acquisition of goods
and the use of services give rise to trade payables (unless paid for in advance or on delivery) and the
receipt of a bank loan results in an obligation to repay the loan. An entity may also recognize future
rebates based on annual purchases by customers as liabilities; in this case, the sale of the goods in the
past is the transaction that gives rise to the liability.
Some liabilities can be measured only by using a substantial degree of estimation. Some entities describe
these liabilities as provisions. In some countries, such provisions are not regarded as liabilities because
the concept of a liability is defined narrowly so as to include only amounts that can be established without
the need to make estimates. The definition of a liability follows a broader approach. Thus, when a
provision involves a present obligation and satisfies the rest of the definition, it is a liability even if the
amount has to be estimated. Examples include provisions for payments to be made under existing
warranties and provisions to cover pension obligations.
Equity
Although equity is defined as a residual, it may be sub-classified in the balance sheet. For example, in a
corporate entity, funds contributed by shareholders, retained earnings, reserves representing
appropriations of retained earnings and reserves representing capital maintenance adjustments may be
shown separately. Such classifications can be relevant to the decision-making needs of the users of
financial statements when they indicate legal or other restrictions on the ability of the entity to distribute or
otherwise apply its equity. They may also reflect the fact that parties with ownership interests in an entity
have differing rights in relation to the receipt of dividends or the repayment of contributed equity.
The creation of reserves is sometimes required by statute or other law in order to give the entity and its
creditors an added measure of protection from the effects of losses. Other reserves may be established if
national tax law grants exemptions from, or reductions in, taxation liabilities when transfers to such
reserves are made. The existence and size of these legal, statutory and tax reserves is information that
can be relevant to the decision-making needs of users. Transfers to such reserves are appropriations of
retained earnings rather than expenses.
The amount at which equity is shown in the balance sheet is dependent on the measurement of assets
and liabilities. Normally, the aggregate amount of equity only by coincidence corresponds with the
aggregate market value of the shares of the entity or the sum that could be raised by disposing of either
the net assets on a piecemeal basis or the entity as a whole on a going concern basis.
Commercial, industrial and business activities are often undertaken by means of entities such as sole
proprietorships, partnerships and trusts and various types of government business undertakings. The
legal and regulatory framework for such entities is often different from that applying to corporate entities.
For example, there may be few, if any, restrictions on the distribution to owners or other beneficiaries of
amounts included in equity. Nevertheless, the definition of equity and the other aspects of this Conceptual
Framework that deal with equity are appropriate for such entities.
Performance
Profit is frequently used as a measure of performance or as the basis for other measures, such as return
on investment or earnings per share. The elements directly related to the measurement of profit are
income and expenses. The recognition and measurement of income and expenses, and hence profit,
depends in part on the concepts of capital and capital maintenance used by the entity in preparing its
financial statements. These concepts are discussed in later session.
The elements of income and expenses are defined as follows:
(a) Income is increases in economic benefits during the accounting period in the form of inflows or
enhancements of assets or decreases of liabilities that result in increases in equity, other than
those relating to contributions from equity participants.
(b) Expenses are decreases in economic benefits during the accounting period in the form of
outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other
than those relating to distributions to equity participants.
The definitions of income and expenses identify their essential features but do not attempt to specify the
criteria that would need to be met before they are recognized in the income statement.
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Income and expenses may be presented in the income statement in different ways so as to provide
information that is relevant for economic decision-making. For example, it is common practice to
distinguish between those items of income and expenses that arise in the course of the ordinary activities
of the entity and those that do not. This distinction is made on the basis that the source of an item is
relevant in evaluating the ability of the entity to generate cash and cash equivalents in the future; for
example, incidental activities such as the disposal of a long-term investment are unlikely to recur on a
regular basis. When distinguishing between items in this way consideration needs to be given to the
nature of the entity and its operations. Items that arise from the ordinary activities of one entity may be
unusual in respect of another.
Distinguishing between items of income and expense and combining them in different ways also permits
several measures of entity performance to be displayed. These have differing degrees of inclusiveness.
For example, the income statement could display gross margin, profit or loss from ordinary activities
before taxation, profit or loss from ordinary activities after taxation, and profit or loss.
Income
The definition of income encompasses both revenue and gains. Revenue arises in the course of the
ordinary activities of an entity and is referred to by a variety of different names including sales, fees,
interest, dividends, royalties and rent.
Gains represent other items that meet the definition of income and may, or may not, arise in the course of
the ordinary activities of an entity. Gains represent increases in economic benefits and as such are no
different in nature from revenue. Hence, they are not regarded as constituting a separate element in this
Conceptual Framework.
Gains include, for example, those arising on the disposal of non-current assets. The definition of income
also includes unrealized gains; for example, those arising on the revaluation of marketable securities and
those resulting from increases in the carrying amount of long-term assets. When gains are recognized in
the income statement, they are usually displayed separately because knowledge of them is useful for the
purpose of making economic decisions.
Gains are often reported net of related expenses.
Various kinds of assets may be received or enhanced by income; examples include cash, receivables
and goods and services received in exchange for goods and services supplied. Income may also result
from the settlement of liabilities. For example, an entity may provide goods and services to a lender in
settlement of an obligation to repay an outstanding loan.
Expenses
The definition of expenses encompasses losses as well as those expenses that arise in the course of the
ordinary activities of the entity. Expenses that arise in the course of the ordinary activities of the entity
include, for example, cost of sales, wages and depreciation. They usually take the form of an outflow or
depletion of assets such as cash and cash equivalents, inventory, property, plant and equipment.
Losses represent other items that meet the definition of expenses and may, or may not, arise in the
course of the ordinary activities of the entity. Losses represent decreases in economic benefits and as
such they are no different in nature from other expenses. Hence, they are not regarded as a separate
element in this Conceptual Framework.
Losses include, for example, those resulting from disasters such as fire and flood, as well as those arising
on the disposal of non-current assets. The definition of expenses also includes unrealized losses, for
example, those arising from the effects of increases in the rate of exchange for a foreign currency in
respect of the borrowings of an entity in that currency. When losses are recognized in the income
statement, they are usually displayed separately because knowledge of them is useful for the purpose of
making economic decisions. Losses are often reported net of related income.
Recognition of the elements of financial statements
Recognition is the process of incorporating in the balance sheet or income statement an item that meets
the definition of an element and satisfies the criteria for recognition set out in paragraph 4.38. It involves
the depiction of the item in words and by a monetary amount and the inclusion of that amount in the
balance sheet or income statement totals. Items that satisfy the recognition criteria should be recognized
in the balance sheet or income statement. The failure to recognize such items is not rectified by
disclosure of the accounting policies used nor by notes or explanatory material.
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An item that meets the definition of an element should be recognized if:
(a) it is probable that any future economic benefit associated with the item will flow to or from the
entity; and
(b) the item has a cost or value that can be measured with reliability.
In assessing whether an item meets these criteria and therefore qualifies for recognition in the financial
statements, regard needs to be given to the materiality considerations discussed in Qualitative
characteristics of useful financial information. The interrelationship between the elements means that an
item that meets the definition and recognition criteria for a particular element, for example, an asset,
automatically requires the recognition of another element, for example, income or a liability. Information
is reliable when it is complete, neutral and free from error.
The probability of future economic benefit
The concept of probability is used in the recognition criteria to refer to the degree of uncertainty that the
future economic benefits associated with the item will flow to or from the entity. The concept is in keeping
with the uncertainty that characterizes the environment in which an entity operates. Assessments of the
degree of uncertainty attaching to the flow of future economic benefits are made on the basis of the
evidence available when the financial statements are prepared. For example, when it is probable that a
receivable owed to an entity will be paid, it is then justifiable, in the absence of any evidence to the
contrary, to recognize the receivable as an asset. For a large population of receivables, however, some
degree of non-payment is normally considered probable; hence an expense representing the expected
reduction in economic benefits is recognized.
Reliability of measurement
The second criterion for the recognition of an item is that it possesses a cost or value that can be
measured with reliability. In many cases, cost or value must be estimated; the use of reasonable
estimates is an essential part of the preparation of financial statements and does not undermine their
reliability. When, however, a reasonable estimate cannot be made the item is not recognized in the
balance sheet or income statement. For example, the expected proceeds from a lawsuit may meet the
definitions of both an asset and income as well as the probability criterion for recognition; however, if it is
not possible for the claim to be measured reliably, it should not be recognized as an asset or as income;
the existence of the claim, however, would be disclosed in the notes, explanatory material or
supplementary schedules.
An item that, at a particular point in time, fails to meet the recognition criteria in paragraph 4.38 may
qualify for recognition at a later date as a result of subsequent circumstances or events.
An item that possesses the essential characteristics of an element but fails to meet the criteria for
recognition may nonetheless warrant disclosure in the notes, explanatory material or in supplementary
schedules. This is appropriate when knowledge of the item is considered to be relevant to the evaluation
of the financial position, performance and changes in financial position of an entity by the users of
financial statements.
Recognition of assets
An asset is recognized in the balance sheet when it is probable that the future economic benefits will flow
to the entity and the asset has a cost or value that can be measured reliably.
An asset is not recognized in the balance sheet when expenditure has been incurred for which it is
considered improbable that economic benefits will flow to the entity beyond the current accounting period.
Instead such a transaction results in the recognition of an expense in the income statement. This
treatment does not imply either that the intention of management in incurring expenditure was other than
to generate future economic benefits for the entity or that
management was misguided. The only implication is that the degree of certainty that economic benefits
will flow to the entity beyond the current accounting period is insufficient to warrant the recognition of an
asset.
Recognition of liabilities
A liability is recognized in the balance sheet when it is probable that an outflow of resources embodying
economic benefits will result from the settlement of a present obligation and the amount at which the
settlement will take place can be measured reliably. In practice, obligations under contracts that are
equally proportionately unperformed (for example, liabilities for inventory ordered but not yet received) are
generally not recognized as liabilities in the financial statements. However, such obligations may meet the
definition of liabilities and, provided the recognition criteria are met in the particular circumstances, may
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qualify for recognition. In such circumstances, recognition of liabilities entails recognition of related assets
or expenses.
Recognition of income
Income is recognized in the income statement when an increase in future economic benefits related to an
increase in an asset or a decrease of a liability has arisen that can be measured reliably. This means, in
effect, that recognition of income occurs simultaneously with the recognition of increases in assets or
decreases in liabilities (for example, the net increase in assets arising on a sale of goods or services or
the decrease in liabilities arising from the waiver of a debt payable).
The procedures normally adopted in practice for recognizing income, for example, the requirement that
revenue should be earned, are applications of the recognition criteria in this Conceptual Framework. Such
procedures are generally directed at restricting the recognition as income to those items that can be
measured reliably and have a sufficient degree of certainty.
Recognition of expenses
Expenses are recognized in the income statement when a decrease in future economic benefits related to
a decrease in an asset or an increase of a liability has arisen that can be measured reliably. This means,
in effect, that recognition of expenses occurs simultaneously with the recognition of an increase in
liabilities or a decrease in assets (for example, the accrual of employee entitlements or the depreciation of
equipment).
Expenses are recognized in the income statement on the basis of a direct association between the costs
incurred and the earning of specific items of income. This process, commonly referred to as the matching
of costs with revenues, involves the simultaneous or combined recognition of revenues and expenses
that result directly and jointly from the same transactions or other
events; for example, the various components of expense making up the cost of goods sold are
recognized at the same time as the income derived from the sale of the goods. However, the application
of the matching concept under this Conceptual Framework does not allow the recognition of items in the
balance sheet which do not meet the definition of assets or liabilities.
When economic benefits are expected to arise over several accounting periods and the association with
income can only be broadly or indirectly determined, expenses are recognized in the income statement
on the basis of systematic and rational allocation procedures. This is often necessary in recognizing the
expenses associated with the using up of assets such as property, plant, equipment, goodwill, patents
and trademarks; in such cases the expense is referred to as depreciation or amortization. These
allocation procedures are intended to recognize expenses in the accounting periods in which the
economic benefits associated with these items are consumed or expire.
An expense is recognized immediately in the income statement when an expenditure produces no future
economic benefits or when, and to the extent that, future economic benefits do not qualify, or cease to
qualify, for recognition in the balance sheet as an asset.
An expense is also recognized in the income statement in those cases when a liability is incurred without
the recognition of an asset, as when a liability under a product warranty arises.
Measurement of the elements of financial statements
Measurement is the process of determining the monetary amounts at which the elements of the financial
statements are to be recognized and carried in the balance sheet and income statement. This involves
the selection of the particular basis of measurement.
A number of different measurement bases are employed to different degrees and in varying combinations
in financial statements. They include the following:
(a) Historical cost. Assets are recorded at the amount of cash or cash equivalents paid or the fair
value of the consideration given to acquire them at the time of their acquisition. Liabilities are
recorded at the amount of proceeds received in exchange for the obligation, or in some
circumstances (for example, income taxes), at the amounts of cash or cash equivalents expected
to be paid to satisfy the liability in the normal course of business.
(b) Current cost. Assets are carried at the amount of cash or cash equivalents that would have to be
paid if the same or an equivalent asset was acquired currently. Liabilities are carried at the
undiscounted amount of cash or cash equivalents that would be required to settle the obligation
currently.
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(c) Realizable (settlement) value. Assets are carried at the amount of cash or cash equivalents that
could currently be obtained by selling the asset in an orderly disposal. Liabilities are carried at
their settlement values; that is, the undiscounted amounts of cash or cash equivalents expected
to be paid to satisfy the liabilities in the normal course of business.
(d) Present value. Assets are carried at the present discounted value of the future net cash inflows
that the item is expected to generate in the normal course of business. Liabilities are carried at
the present discounted value of the future net cash outflows that are expected to be required to
settle the liabilities in the normal course of business.
The measurement basis most commonly adopted by entities in preparing their financial statements is
historical cost. This is usually combined with other measurement bases. For example, inventories are
usually carried at the lower of cost and net realizable value, marketable securities may be carried at
market value and pension liabilities are carried at their present value. Furthermore, some entities use the
current cost basis as a response to the inability of the historical cost accounting model to deal with the
effects of changing prices of non-monetary assets.
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